Working Paper: NBER ID: w28824
Authors: Nicolae B. Grleanu; Stavros Panageas; Geoffery X. Zheng
Abstract: We document the historically bad performance of shorting strategies in late 2020 and early 2021. Short sellers started retreating several weeks before the dramatic growth in the online discussion of January 2021 and across numerous stocks, the majority of which were not heavily discussed online and did not experience an unusual increase in retail buying volume. We provide a model to explain how fears among short sellers can become self-fulfilling and lead to “run-type” behavior. The model also provides a novel explanation why rational short sellers may choose to leave the market even as mispricing widens.
Keywords: short selling; market dynamics; self-fulfilling prophecies
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| decline in short interest (G14) | fearful response to shifting market environment (G41) |
| short selling behavior (G41) | self-fulfilling prophecy (D84) |
| feedback loop between Sharpe ratio and short interest (G40) | decrease in short selling activity (G14) |
| exit of rational sellers (D41) | rise in stock prices (G17) |
| perceived risk (D81) | decrease in short selling activity (G14) |
| conditions favoring high short interest (G14) | impact decisions of rational short sellers (G41) |
| conditions favoring low short interest (G14) | impact decisions of rational short sellers (G41) |